The hot topic right now is whether the recent pickup in inflation is transitory (as the Federal Reserve believes) or here to stay. Inflation, defined as a rise in the prices of goods and services in an economy, reduces our purchasing power. If you can grow your money by at least the rate of inflation (approximately 2% per year right now), you can maintain your purchasing power. Unfortunately, if you have checked the interest rate on your “high yield savings” account recently, you know that you are not earning anywhere near 2%. Inflation is one of the primary reasons why we invest.
In the last few months, commodity prices have spiked (think: lumber, oil, copper, etc.), real estate values have soared, and the stock market keeps making new all-time highs. Suddenly there is a real fear that inflation may rise uncontrollably - forcing the Federal Reserve to raise interest rates to slow down the economy.
For the past 14 months, we have seen a dramatic shift in both the supply and demand of goods and services. Because of the shut down, we were not able to spend money on services such as airfare, restaurants, movies, and sports. At the same time, many received stimulus checks, enhanced unemployment benefits, and/or Paycheck Protection Program (PPP) money. With limited opportunities for spending, the savings rate in the U.S., which historically runs at approximately 7%, jumped to 21%! Instead of spending on services, we saved, paid down credit card debt and spent more money on products such as cars, pools for our backyards, and computer equipment for our new home offices.
Demand always adjusts faster than supply. Remember when we had a toilet paper shortage? Demand increased dramatically as people started panicking. It took manufacturers a little while to catch up but the shortage eventually disappeared. The same thing happened with masks…we had a shortage and then we didn’t. A few weeks ago, the Colonial Pipeline was hacked and we saw videos of people filling plastic bags with gasoline as they feared a shortage. That too was short lived.
As the economy reopens, we believe we will see a reversion back to our old habits with spending on services surging and spending on goods declining rather dramatically. There is enormous pent-up demand for travel, leisure and all forms of entertainment. We are already seeing an uptick in these demands. And practically speaking, if you bought a car/couch/computer last year, how likely are you to buy another one this year?
What about wages?
Many economists believe (and we agree) that inflation is only sustainable if wages rise and consumers have more money to spend. Wages have started to pick up but we would argue they are rising for the wrong reasons. According to the Bureau of Labor and Statistics, there are almost 10 million people still unemployed but many of them are not rushing back into the workforce because they are receiving substantial Federal and State unemployment benefits. This is forcing employers to “pay up” for workers from an artificially small pool of labor. As soon as the supplemental unemployment benefits expire, we will likely see more workers looking for jobs and a slowdown in wage growth.
What does this mean for your investments?
Let’s turn to the capital markets. Both the stock and bond markets tend to be forward looking, pricing in data that is anticipated over the next 6-12 months. What’s happening today (and what you are hearing about in the media) is likely already reflected in stock prices and interest rates. To profitably invest, we have to look ahead and try to determine how things might look in the future. At Clarus Group, we focus on themes rather than forecasts.